Harvard Case - The Kashagan Production Sharing Agreement (PSA)
"The Kashagan Production Sharing Agreement (PSA)" Harvard business case study is written by Benjamin C. Esty, Florian Bitsch. It deals with the challenges in the field of Finance. The case study is 22 page(s) long and it was first published on : May 7, 2013
At Fern Fort University, we recommend a thorough review and renegotiation of the Kashagan Production Sharing Agreement (PSA) to address the significant challenges faced by the consortium. This should involve a comprehensive analysis of the financial structure, risk allocation, and operational efficiency of the project, with a focus on maximizing shareholder value while mitigating potential risks.
2. Background
The Kashagan oil field, located in the Caspian Sea, is one of the largest oil discoveries in recent history. The development of this field was undertaken by a consortium of international oil companies, including Eni, ExxonMobil, Shell, Total, ConocoPhillips, and KazMunayGas (KMG). The project was governed by a Production Sharing Agreement (PSA), which outlined the terms of the partnership between the consortium and the Kazakh government.
The case study highlights the numerous challenges faced by the consortium, including:
- High development costs: The project faced significant cost overruns due to technical complexities, environmental concerns, and delays in construction.
- Complex operating environment: The remote location, harsh weather conditions, and political instability in the region posed significant operational challenges.
- Disagreements over profit sharing: The consortium and the Kazakh government clashed over the distribution of profits generated from the oil field.
- Environmental concerns: The project faced scrutiny over its potential environmental impact on the Caspian Sea ecosystem.
Main Protagonists:
- Consortium: The group of international oil companies responsible for developing the Kashagan field.
- Kazakh Government: The sovereign entity holding ownership of the oil field and negotiating the PSA with the consortium.
- KMG: The Kazakh national oil company, a key stakeholder in the project.
3. Analysis of the Case Study
The case study can be analyzed using a framework that encompasses the following key aspects:
- Financial Analysis: The consortium's financial performance needs to be assessed, focusing on the profitability of the project, the cost of capital, and the return on investment (ROI). This analysis should include a detailed examination of the financial statements, cash flow projections, and the impact of the PSA on the consortium's overall financial position.
- Risk Assessment: The case study highlights numerous risks associated with the project, including operational risks, political risks, environmental risks, and financial risks. A thorough risk assessment should be conducted to identify, quantify, and prioritize these risks, allowing for the development of mitigation strategies.
- Strategic Analysis: The consortium's strategic goals and objectives need to be aligned with the long-term viability of the project. This analysis should consider the consortium's competitive position, the market for oil, and the evolving political landscape in Kazakhstan.
- Operational Analysis: The efficiency and effectiveness of the project's operations should be assessed, considering factors such as production capacity, cost optimization, and environmental sustainability.
4. Recommendations
To address the challenges faced by the consortium, the following recommendations are proposed:
- Renegotiate the PSA: The consortium should initiate negotiations with the Kazakh government to revise the PSA, addressing key issues such as profit sharing, risk allocation, and the cost structure. This renegotiation should aim to create a more equitable and sustainable partnership, ensuring a fair return on investment for the consortium while acknowledging the government's interests.
- Optimize Operations: The consortium should implement a comprehensive operational efficiency program, focusing on cost reduction, process improvement, and technology adoption. This could involve exploring alternative technologies for oil extraction, streamlining logistics, and optimizing the use of resources.
- Enhance Risk Management: The consortium should strengthen its risk management framework, focusing on identifying, assessing, and mitigating potential risks. This could involve developing contingency plans for unforeseen events, implementing robust environmental protection measures, and engaging in proactive political risk management.
- Improve Communication and Collaboration: The consortium should foster stronger communication and collaboration with the Kazakh government, KMG, and other stakeholders. This could involve establishing a joint working group to address key issues, promoting transparency, and building trust through open dialogue.
5. Basis of Recommendations
These recommendations are based on the following considerations:
- Core Competencies: The consortium's core competencies lie in oil exploration, development, and production. The recommendations aim to leverage these competencies while addressing the specific challenges of the Kashagan project.
- External Customers and Internal Clients: The recommendations consider the interests of both the consortium's shareholders and the Kazakh government, aiming to create a win-win scenario for all stakeholders.
- Competitors: The recommendations acknowledge the competitive landscape in the oil industry and aim to position the consortium for long-term success.
- Attractiveness: The recommendations are expected to improve the project's profitability, reduce risks, and enhance the consortium's overall financial performance.
6. Conclusion
The Kashagan project presents a complex and challenging case study, highlighting the intricate dynamics of international business, government relations, and the oil industry. By implementing the recommendations outlined above, the consortium can navigate these challenges, optimize the project's performance, and maximize shareholder value.
7. Discussion
Other alternatives not selected include:
- Withdrawal from the project: This option would involve the consortium relinquishing its stake in the Kashagan project, potentially leading to significant financial losses.
- Continuing with the existing PSA: This option would maintain the current terms of the agreement, potentially leading to continued challenges and conflicts.
Risks and Key Assumptions:
- Political instability: The political situation in Kazakhstan could deteriorate, impacting the project's stability and profitability.
- Environmental regulations: Stricter environmental regulations could increase the project's costs and complexity.
- Oil price volatility: Fluctuations in oil prices could impact the project's profitability.
8. Next Steps
To implement these recommendations, the consortium should:
- Establish a dedicated task force: This task force would be responsible for leading the renegotiation of the PSA, implementing operational improvements, and enhancing risk management.
- Develop a detailed implementation plan: This plan should outline the specific actions to be taken, timelines for completion, and the resources required.
- Engage with key stakeholders: The consortium should proactively engage with the Kazakh government, KMG, and other stakeholders to build consensus and ensure a smooth implementation process.
By taking these steps, the consortium can transform the Kashagan project from a source of challenges into a successful and profitable venture.
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Case Description
When discovered in the 1990s, the Kashagan oil field was the second largest oil field in the world. The project sponsors (equity investors) signed a 40-year production sharing agreement (PSA) with the Kazakh government in 1997, with the expectation the field would be developed at a total cost of $57 billion and would be pumping oil by 2005. Unlike most contracts in the energy industry, the Kashagan agreement was a "flexible PSA" meaning the contractual terms-the allocation of risks and returns-depended on ex post realizations of such things as capital costs and profitability. The parties incorporated contingencies into the contract to make it fairer and more flexible, and to ensure it remain viable over the project's 40-year life. Due to a combination of problems and challenges, the project was still not done in mid-2007. At that time, the sponsors, led by the Italian energy company ENI, announced the project would not be completed until 2010 and the total cost was likely to be $136 billion. Although oil prices had risen dramatically between 1997 and 2007, thereby making the project worth considerably more, the Kazakh government indicated its desire to renegotiate key provisions of the contract. The sponsors had to decide whether to renegotiate the contract and, if so, which parts.
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